Short Put Butterfly is identical to the Short Call Butterfly, except that it
uses puts instead of calls. It is the opposite of a Long Put Butterfly, which is
a rangebound strategy. The reason that short butterflies are not particularly
popular is because even though they produce a net credit, they offer very small
returns compared with straddles and strangles with only slightly less risk.
Short Put Butterfly involves a low strike short put, two at-the-money long
puts, and an in-the-money short put. The resulting position is profitable in
the event of a big move by the stock. The problem is that the reward is
seriously capped and is typically dwarfed by the potential risk if the stock
fails to move.
this strategy when you anticipate big volatility in a stock price, in either direction,
and want a capital gain on the trade.
is trading at $50 on May 14, 2011.
August 2011 45 strike put for $2.57.
2 August 2011 50 strike puts at $4.83.
August 2011 55 strike put for $7.85.
credit: premiums sold minus premiums bought = $0.76
benefit is that with no capital outlay you have the possibility of profiting
from a rangebound stock, with your risk capped.
risk is the difference between adjacent strikes minus the net credit. The
reward is the net credit you receive.
in adjacent strikes minus net credit.
even up: higher strike minus net credit.
even down: lower strike plus net credit.
unless the stock moves to the outside of the outer stikes.
Of Time Decay
since you have to wait for a big movement in the stock.
stem a loss, unravel the trade.
out the position by selling the options you bought and buying back the options